Investing > Day Trading Options

Day Trading Options

There's a lot to unpack with day trading options. This guide covers it all.

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Updated January 08, 2021

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With COVID-19, the past year has been a rollercoaster for our little planet—including the stock market. 🌎 📈

By and large, stocks have seen huge drops and unprecedented jumps in the previous months. This created a trading environment that is as volatile as it is full of opportunity, and many investors have jumped on the day trading bandwagon.

This goes especially for options traders—in October alone we have had almost $600 million calls and puts traded in the US. Compared to the same month last year, this is a 48% increase, which goes to tell us that many people have cause to trade.

The reasons why the number of options traders soared recently are many—but most newcomers are entering the game to make up the losses they experienced during the lockdown by trading in today’s opportunity-rich market. However, not all rookies will have a good time—day trading options isn’t something you should get into without a plan.

Don’t make the rookie mistake of diving in unprepared! ⚠️

Before you can reliably make a buck through options, you should know how to do your research, find the right broker, and have a strategy that works. After this is taken care of, it all comes down to practice and discipline—but if you can start making money right off the bat, all the better.

In this guide, we will explain some of the popular strategies for day traders that you can implement today and improve your gains while minimizing risk. Not all stocks can be traded the same way, so let’s see how options work and what are the most effective ways to trade them. 

What you’ll learn
  • How Day Trading Options Works
  • What Types of Options Are There?
  • Is Day Trading Options Right for You?
  • How to Day Trade Options
  • Key Strategies
  • Tips For Options Day Traders
  • Before You Start Trading
  • Get Started With a Broker

How Day Trading Options Works

An options contract allows you to buy or sell an asset for an agreed-upon price within a certain timeframe. Therefore, traders can use these contracts to essentially bet on assets they think are going to lose or gain value.

In this sense, options differ from stocks significantly: instead of buying shares directly, you can buy a contract that allows you to purchase or sell the security in question at a later date, and at today’s price. So, if you can predict the price movement, you win—but if you make a mistake, you can still sell your contract and get out of your position before taking a big loss. 

This kind of trading is a bit more complicated than buying and selling stocks, which is relatively straightforward. Nonetheless, day traders like these financial instruments so much because they can hedge risk with options, as well as open and close positions more quickly. All in all, this slightly more complicated way of trading can yield greater results if done correctly.

What Types of Options Are There?

Options might seem a bit more complicated than stocks but there are only a few basic types of options—one for buying stocks, one for selling, and one for making cash bets on stock prices. Here is how they all work.

Put Options 👇

A put option is a contract that allows you to sell shares (usually 100 per contract) at today’s price during a certain time frame. If you think a stock is going to lose value in the future, you can get a put option and sell the stock above its price when it goes down.

Call Options 📞

Opposite to put options, call options give you the right to buy stocks at today’s price within a certain timeframe. If you’re bullish about a stock, you can get a call option and buy it for today’s price in the future when it is worth much more.

Binary Options 1️⃣ 0️⃣

As the name implies, binary options have two possible outcomes—yes or no. These options have an expiry date, and if the price of the underlying asset is on the right side of the strike price at that time, you profit. It’s as simple as that—you bet on where the price is going, and if your foresight is correct, you get rewarded.. 

The payoff here is fixed—if you predict the future price of a stock, for example, you get paid automatically. In a sense, binary options are similar to betting, which is why this type of trading is highly regulated and even unavailable with some brokers.

🏆 Interested in binary options? Check out the top platforms for binary options trading to learn more.

Should You Day Trade Options? ⚖️

Truth be told, trading options is different animal when compared to stocks, forex, and other financial instruments. Options have a suite of benefits—they allow you to hedge risk and have high liquidity. Here is what this means:

For example, if you have an option that lets you buy a stock at today’s price two days from now and the said stock rises in value, you can buy it below the price. If things aren’t going as well as you hoped, you can sell the option before it expires and mitigate your losses.

However, where options are superior to stocks as a trading tool is liquidity. Essentially, you need to find a buyer before you can sell a stock, which can take a lot of time. Opposite to that, an option is a contract that allows you to buy or sell the underlying asset immediately. This is why options are handy for day traders—you won’t lose money while waiting for a buyer.

Hedging risk is also often easier with options—you can sell your options contract if it looks like you’re going to lose your bet. For example, if you believe a stock is going to increase in value in the future, you would get a call option for it. However, if it suddenly starts going down before the option has expired, you can sell your contract (at a slightly lower price) and limit your losses—this would be much harder than a tanking stock.

One more very enticing fact about options is that they require a much smaller initial capital than stocks. You don’t have to buy a full share of a stock to make money off of it if you use options and you can leverage your trades. This means you can use borrowed money to make low-risk trades and make stronger profits than you would have using just your own money.

How to Day Trade Options 📚

In part, day trading options is very similar to trading stocks, indices, and other securities. First and foremost, you need to know how to analyze stocks so you know whether they are worth trading at all—but the type of assets you will trade will depend on your overall strategy.

There are ways to make money on rising, falling, and stagnant securities using options but it’s best to pick just one of these categories—focusing on one type of trading will produce greater results than doing a bit of everything. This is especially true if you are a new trader and are looking to learn how to trade options.

Access to trading options has become very easy with online brokers – but trading them requires strategy.

If you have a plan and the know-how, the next most important thing is a cheap, reliable broker. Online brokerages nowadays cater to different kinds of investors, and you should only use the top brokers for options trading—these specialized trading platforms are dramatically cheaper and more feature-rich than the competition when it comes to options trading.

The last, but a necessary ingredient in starting a day trading career is a starting capital. To legally be able to make more than 3 trades a day, you need to have at least $25,000 in your brokerage account at all times—if your balance drops even one dollar below the minimum requirement, you cannot day trade.

Options Day Trading Strategies 💡

Day trading isn’t the simplest profession in the world, but options can make it more complicated still—that’s why you need a logical and effective strategy. If you can master just one of the popular strategies for trading options, you’ll be ahead of most of your peers.

This is not an over-exaggeration—options day traders are more numerous than ever, but their ranks mostly consist of newcomers, rather than experienced investors. Keeping that in mind, let’s see what the best strategies are and how they can help you trade securities more easily and effectively than the competition.

Long Call and Put ✅

This can hardly be called a strategy because it is the most simple and intuitive way of using options. Essentially, if you think a stock is going up, get a call option instead of buying actual shares. Similarly, get a put option if you’re confident the price is going to go down.

The cases where you can bet on a stock with confidence might be rare, but if you have the opportunity, options are the way to go—the premiums are fairly cheap compared to what you can make, and you can cash in your position at a moment’s notice. However, make sure to complete your trade before the option expires, or else your entire position will be worth $0.

Pros

  • There are no limiting factors for potential profits
  • The easiest strategy to use

Cons

  • Maximum losses are higher than with most other strategies
  • Profits are entirely dependent on your predictions of the underlying asset’s price movement

Bull Call Spread 🐂

This strategy only works if a stock you are looking at is experiencing an upward trend. To perform a bull call spread, you need to buy one option and sell another with a higher strike price. If the price of the stock reaches a point between the strike prices of the two options, you’ll make the maximum profit. Here is an example:

Let’s say you buy a long call option for a premium of $20 with a strike price of $100. Then, let’s say you sell a short call option for $6, but this one has a less-realistic strike price of $140 (and this unrealistic strike price makes it cheaper). This leaves you with a $14 expense—cheaper than if you only bought the first call option. There are three scenarios as to how this trade can play out:

First Scenario (Profit) 📈

If the price of the underlying asset at expiration date sits between the strike prices of the two options, you will see a good profit. You will be able to cash in your long call option whereas your short option will expire and become worthless. Therefore, with an investment of $14, you would make a profit of up to $26.

Max profit = Short option strike price – Long option strike price – Premiums
($26 = $140 – $100 – $14)

Second Scenario (Break-Even) 😐

If the stock price at the expiration date is equal to your long call option strike price plus premiums, you’ll break even. For example, If the strike price is $100, and your premiums total $14, you’ll be at $0 if the price of the stock is $114 at the expiration date. 

Break-even point = Long call option strike price + Premiums
($114 = $100 + $14)

Third Scenario (Lose Money) 📉

If the long call options strike price is lower than the break-even point at the expiration date, you’ll be at a loss. The maximum loss you can experience is the total price of premiums, which is $14 in this case. If you just bought the long option without selling the short one, your losses would be $20 in this case—this is why this strategy is good for hedging risk.

Max loss = Premiums ($14)

Pros

  • Lower risk than outright buying a call option
  • Maximum reward is much higher than the maximum loss

Cons

  • Limited profit potential

Bear Put Spread 🐻

As you might’ve guessed from the name, a bear put spread is the opposite of a bull call spread. Essentially, this means buying a long put option and selling another short put option with a lower strike price.

Like with the previous strategy, your profits here are maximized when the price of the underlying asset reaches a point just above the strike price of the short option. This strategy works for moderately downward-trending assets, and it will yield higher total profits than buying a single put option if successful.

Pros

  • Lower risk than outright buying a put option
  • Maximum reward is much higher than the maximum loss

Cons

  • Limited profit potential

Straddle ⚡️

If you like hedging risk, you can always straddle. This strategy implies buying a call and a put option with the same strike price, and with the same expiration date. Basically, you’re betting on a stock and against it at the same time—and it doesn’t matter whether the price of the stock goes up or down, as long as the movement is big enough.

To make a profit like this, you need the price to go up or down enough so that your gross profits are higher than the total premiums of both options you bought. For example, if the call option cost you $10 and the put option was $8, you’re in the green as long as you make more than $18 with this trade.

Traders use straddle when they are unsure where the price is going but think the movement will be intense. For instance, a trader might use this tactic right before a major press conference where a company will announce its latest big project. 

Events like these tend to temporarily increase or decrease the stock price of a company considerably, and straddle is a safe way to profit from this large price movement. However, if the price doesn’t move enough, your total premiums will be higher than your gross profit and you will lose money.

Pros

  • Unlimited profit potential with limited maximum loss
  • Profits from large price movements in any direction
  • Great strategy for catching black swans

Cons

  • Can fail if you don’t gauge an asset’s volatility correctly
  • Options are usually priced accordingly, minimizing profit potential

Strangle 🐍

The strangle strategy is similar to the straddle strategy but is used for even more substantial price changes. To do the strangle, you need to buy a put and a call option, but with different strike prices—lower put and higher call.

The larger spread means that the premiums will be cheaper, but it also means that you need a more dramatic price chance to make a profit. Essentially, straddle is a safe strategy for moderate price changes, while strangle only works for significant jumps or drops in stock value.

Pros

  • Unlimited reward potential
  • You can resell your options to hedge risk

Cons

  • Riskier than strangle
  • Requires large price movements

Butterfly 🦋

The butterfly strategy is a bit more complex as it requires 4 options in total. First, you need to sell 2 call options contracts with the same strike price which is usually the current price of the underlying asset. Then, you need to buy a call option with a higher strike price, as well as a call option with a lower strike price.

Let’s say you sold the 2 call options for a total of $50 and bought the other two for $40 and $35. In this case, your maximum loss would be $25 and your maximum profit would also be $25.

The butterfly strategy is used to bet on small price changes—if the change is limited, you profit, but if it is higher than expected, you are protected from large losses by the two options you sold.

Pros

  • Safe strategy in a less volatile market

Cons

  • Requires buying multiple options which may eat your profits
  • More complicated to execute correctly

Covered Call ☎️

This is a safe long strategy that requires you to own the underlying asset and sell the call options you wrote for it. If you own company XYZ shares, you can write call options with a high strike price and sell them to willing buyers—here is why owning actual shares of XYZ is beneficial.

If the price of XYZ goes above the strike price, you would usually be at a large loss. However, you can just sell the shares you own if the price goes up and negate your losses.

On the other hand, if the price of XYZ doesn’t reach your option’s strike price, then you just win as the option you sold becomes worthless on its expiration date. The covered call strategy is used by investors who think their stocks will grow in the long run but don’t expect significant growth in the short term. If done correctly, this tactic can let you exert even more money-making potential from the slow-growing securities you own.

Pros

  • You can use your non-volatile stocks to make a regular profit
  • Selling the underlying asset means you can’t be at a loss

Cons

  • Will limit your profits if your stock grows more than expected
  • You need to buy back your call options before you can sell the underlying asset

Tips For Options Day Traders 👨‍🏫

Options are a very versatile and powerful tool, especially for day trading where saving a single dollar on a trade counts for a lot in the long run. Here are a few qualities that seasoned options traders hold in high regard and you should too if you’re looking to make the most of your investments.

Be Great at Hedging Risk ⚡️

Before making any options trades, you must ask yourself a few questions—how likely is this to succeed? How much will I lose at most? What percentage of my portfolio is it safe to invest?

Options day traders use the aforementioned strategies to minimize their potential losses but also diversify their portfolios as much as possible. Even when leveraging the top brokers for day trading, investors don’t leave their positions to sit overnight, just in case some bad news comes in at the last moment, ruining their trade.

Moreover, an options trader should be a good money manager. For example, betting 50% of your portfolio on a single trade is not prudent, even if chances of success are high. Most pro day traders invest about 0.5% to 1.5% of their portfolio daily and seek to grow it by that same percentage if possible.

Be Disciplined and Cool-Headed 🧘‍♂️

Traders who intend to last long in the markets don’t follow the crowd and panic sell on the first sign of a recession. It pays to stick to your long-term strategy and remain rational at all times. This might be hard when your own money is on the line, but remember what Warren Buffet’s rule no. 1 of investing is—never lose money.

Also, since day trading won’t make you rich overnight, your best approach is to be patient and disciplined. Taking a high-risk, high-reward position might be tempting, but steadily growing your portfolio day by day is how most successful investors got where they are.

Watch the News 📺

Keeping a close eye on the news is a crucial part of every day trading strategy, image courtesy of CNBC.

Specifically, news about the economy, geopolitics, and the companies you’re investing in. A single major event can send a company’s stock price shooting up or crashing down in a matter of days, so it pays to stay on top of the latest developments.

For example, when the video game publisher Activision Blizzard announced its new mobile game, Diablo Immortal back in 2018, its stock price jumped off a cliff the next day. This drop ignited a strong reaction from shareholders, and the stock continued to fall until it was at about 60% of its former price just 2 months later.

Needless to say, the announcement was not received by the company’s customers and that was enough to bring prices crashing down. All in all, news can make or break certain stocks, so it’s always a good idea to keep a finger on the pulse of the industry you’re investing in.

Never Stop Learning 🎓

Day trading is very unforgiving to those who don’t keep up. Aside from staying on top of the news and the economy at large, you should read up on new techniques and adapt your strategies to the changing environment.

By being an active learner, you will better understand the shifting financial landscape and adapt quickly. If you are good at this, you might even sense new opportunities before anyone else, and be able to strike the iron while it’s hot for maximum profit.

Keep Records 🗂

If you can make maintaining records of your trades a habit, you’ll be able to look at the past and see what work and what doesn’t. Pros keep everything written down and can learn from their mistakes—and whatever helps you get better, will help you make more money.

Keep This in Mind Before You Start Day Trading

Legally speaking, day trading is not for everyone. There are a few trading rules you need to keep in line with, and you should know what happens if you don’t stick to the legal norm.

First of all, to be considered a day trader, you need to make more than 3 trades per day. This means buying and selling or selling short and buying the same security on the same trading day—but this only applies if the trades amount to more than 6% of your total trading activity for the past 5 days. Basically, you don’t have to worry about this rule if you make less than 4 trades per day.

Also, as a day trader, your trading account balance must be $25,000 or higher at all times. With this balance, you are permitted to leverage trades up to four times for all funds that exceed the required minimum—your full balance minus $25,000 is the amount you can leverage fourfold.

If you leverage more than this amount, you will be issued with a margin call. This means you will need to deposit enough money to meet the $25,000 requirement—if you fail to make the deposit in 5 business days. As a penalty, your maximum leverage will be 2x instead of 4x until the balance is restored to where it needs to be.

Moreover, if you don’t sort everything out in 5 business days, you won’t be able to leverage your trades at all for the next 90 days or until the requirement is met. Also, if you make the deposit to satisfy the margin call, the money must sit on your account for 2 entire business days, before the restriction is lifted.

Day Trading During COVID-19

The outbreak of the Coronavirus in early 2020 made it hard for millions to keep jobs and make a living through normal means while keeping everyone locked in quarantine for months. As humans adapt to their environment, we have seen millions of new traders entering the stock market to make a buck from home while the economy is down.

Likewise, the number of day traders has increased dramatically, but not everyone is fairing well. The market has been booming in the past couple of years, but many experts believe that the environment is much riskier for day traders now than it was a year ago. 

Moreover, if we look at the history of the stock market, we can see that huge short-term growth like what we had recently is usually followed by increased volatility. The presidential election also traditionally adds to high volatility in the stock market, so it pays to be careful and trade conservatively until the dust settles.

However, this doesn’t mean that the market cannot work in your favor. For example, Dow Jones has reached a new all-time high recently after positive news about a new COVID-19 vaccine. But a positive spike in market value is not enough to make long-term goals—if high volatility is on the horizon, it pays to play it safe for now.

Day Trading Options - FAQs

  • Is There a Limit on Options Trading?

    Yes, there is a limit on options trading. This limit depends on the total amount of shares and the trading volume of the underlying stock in the past 6 months. Most popular and frequently traded stocks have up to 250,000 maximum contracts that can be bought by traders.

  • Can You Day Trade Options With Robinhood?

    Yes—Robinhood supports options trading and is one of the most popular trading platforms for options traders in the U.S. However, you have to be flagged as a pattern day trader in order to start day trading anything, including options.

  • How Much Money Do You Need To Day Trade?

    $25,000 is the minimum legal requirement for day trading. If your brokerage balance drops below this number, you will not be able to trade and might incur trading restrictions until your balance is restored to the required level.

  • What is Pattern Day Trading?

    Pattern day trader (PTD) is a legal term for investors who make more than three trades per day over the period of 5 business days. You need to be flagged as a PTD to be able to day trade.

Get Started With a Broker

And there you have it – you now know all the crucial aspects to day trading options! 🎉

The next step is to get started with a trustworthy, reliable broker:

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Minimum initial deposit

TS Select: $2,000

TS GO: $0

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Best for

Active options and penny stock trading

Active traders

DIY stock trading

Highlight

Powerful tools for professionals

Huge discounts for high-volume trading

Pioneer of commission-free stock trading

Promotion

Free stock

All reviews, research, news and assessments of any kind on The Tokenist are compiled using a strict editorial review process by our editorial team. Neither our writers nor our editors receive direct compensation of any kind to publish information on tokenist.com. Our company, Tokenist Media LLC, is community supported and may receive a small commission when you purchase products or services through links on our website. Click here for a full list of our partners and an in-depth explanation on how we get paid.

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